China’s bold plan to privatise may extend to banks

As an economic policy it’s hardly sophisticated, but it appears the best way the world’s second-biggest economy and Australia’s largest trading partner can avoid a debilitating debt crisis.

The muddling through process began on August 1, when the central government commenced an “urgent" audit of local government debt – the first such audit in two years. It was confirmation China’s new economic leaders want to know exactly how bad the situation may be.

China’s official media said the audit will be delivered to the State Council – the cabinet – in mid-October. It’s not going to make pretty reading and is also likely to be used as weapon against corrupt local officials. But that’s another story.

The big issue is what effect the audit will have on the ratio of non-performing loans at China’s state-owned commercial banks, and the associated wealth management products.

At present, the overall bad loan figure is a laughably low 0.96 per cent, according to the country’s banking regulator. The governor of the People’s Bank of China,
Zhou Xiaochuan
, appears a little more realistic; he has said about 20 per cent of the debts held by local government finance vehicles (LGFV) might be at risk of default.

That’s a pretty hefty figure given current estimates of LGFV debt are around $2000 billion – it stood at around $1750 billion in 2010. If the central bank governor is close to the mark with his 20 per cent figure, then the central government may need to find at least $500 billion just to bail out the provinces.

There’s also sure to be plenty of other nasties lurking around, given that China’s total government debt has risen to more than 200 per cent of GDP, double the level of four years ago.

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But for foreign investors the really interesting issue is what happens after the audit is completed. A sell-off of local government assets may follow – which will pique the interest of infrastructure investors such as
Macquarie
and the big Canadian pension funds. Assets on the block may include toll roads, water treatment facilities and rail lines.

The central government has already taken an early step towards allowing private capital into rail, after the State Council said in late July it planned to grant ownership and operating rights on some city and regional railways to local governments and private investors. This has never been done before and the motivation seems clear: the government wants to continue its aggressive program of building rail lines, but wants to sell some existing assets to pay for the new construction.

This year alone, the government plans to spend more than $100 billion on railway construction. “To get rich, you must build roads first, especially railroads," Premier
Li Keqiang
was quoted as saying by the official Xinhua news agency.

But the privatisation plan could go even further. The World Bank is said to be working on a major report with a Chinese government advisory panel, which may recommend the privatisation of one of the country’s big five banks.

It’s early days in this process, but it does indicate a large privatisation program is at least on the agenda in Beijing. Before that happens there will be plenty of “muddling through", and confusing reports about the health of China’s financial system. We should see a clear picture on any privatisation program at the conclusion of a Communist Party conclave in late October or early November.